Earning Miles Tops Flying Jets as Smiles Soars: Corporate Brazil

Smiles SA (SMLE3) is outperforming parent Gol Linhas Aereas Inteligentes SA (GOLL3) like no other major airline loyalty program.

Smiles has gained 23 percent in Sao Paulo since its April initial public offering, while Gol tumbled 17 percent after selling a stake in the frequent-flier unit. Local competitor Multiplus SA (MPLU3) sank 25 percent during that time, with Santiago-based parent Latam Airlines Group SA (LAN) falling 20 percent after adjusting for the difference between Brazil’s and Chile’s currencies. In the same period, Air Canada (AC/B) outperformed Aimia Inc (AIM), which manages the carrier’s Aeroplan mileage program.

Use of airline loyalty programs in Brazil is still low when compared with the average in other countries, giving companies such as Smiles “significant” growth potential, said Carlos Daltozo, an analyst at Banco do Brasil SA (BBAS3)’s investment unit. Smiles also profits from agreements with credit card providers, making it less dependent on Gol’s traffic, he said.

“After the IPO, Smiles gained more visibility and became more focused on expanding its business when compared to how things were when it was just part of Gol’s structure,” Daltozo, who rates the stock the equivalent of buy, said in a phone interview from Sao Paulo. “It’s a very attractive industry.”

‘Doing Well’

Smiles, which raised 1.1 billion reais ($500 million) in its April 25 IPO, makes money by exchanging discounted plane tickets it buys from Gol for the value of the frequent-flier miles accrued by passengers, profiting from the difference between the cost of the tickets and the revenue generated from the sale of miles. The airline benefits from the arrangement by removing the liability of the loyalty program from its balance sheet.

The company also gets paid for miles earned through other channels, including credit card providers. Sources other than Gol accounted for 64 percent of second-quarter sales, Smiles said in its latest financial statement.

“Unlike Gol, Smiles doesn’t need to worry about debt, fuel costs or currency swings,” Ivan Kraiser, who helps manage about 500 million reais as a partner at Legan Administracao de Recursos, said by phone from Sao Paulo. “It just needs a stable economy so it can keep generating revenue. So far, the company is doing well.”

Gol’s Losses

Analysts covering Gol, which has reported six consecutive quarterly losses, have cut their 2014 earnings forecasts by 40 percent in the past three months amid concern that a weaker real will push expenses higher. The currency has weakened 7.1 percent this year, and spending on fuel, which in Brazil is priced in dollars, accounts for 41 percent of Gol’s operating costs, according to data compiled by Bloomberg. The airline’s ratio of debt to earnings before interest, taxes, depreciation and amortization is higher than 97 percent of its peers.

Smiles intends to increase its market share in Brazil’s loyalty programs industry, which currently is about 26 percent, by strengthening its relationship with credit card issuers and partnering with retailers, according to a statement on the company’s website.

After the IPO, Smiles boosted its staff to about 60 from 12 employees as it seeks to boost its business, said Chief Financial Officer Flavio Jardim Vargas. Fewer than 5 percent of Brazilians use loyalty programs, which compares with a rate as high as 30 percent in more mature markets, signaling a good growth potential for the industry, he said.

‘Super Optimistic’

“There’s room not only for us to add more clients, but to build closer relationships with the current ones, so they use the program more often,” Vargas said in a phone interview from Sao Paulo. “I’m super optimistic about the outlook for growth.”

Ten of 12 analysts covering Smiles recommend buying the stock, while five of 11 rate Gol a buy, according to data compiled by Bloomberg.

Smiles, which closed yesterday at 26.70 reais, trades at 16.4 times its 2014 forecast earnings, compared with a ratio of 12.5 times for Multiplus. The frequent-flier company’s rally has made the stock too expensive, according to analysts at brokerage Brasil Plural CCTVM including Chris Recouso in Sao Paulo.

‘Too High’

“The loyalty operator is priced too high,” the analysts wrote in a note to clients dated Aug. 12. “This stock, properly priced, would be trading in the 20 reais per share vicinity.” They rate Smiles underweight, meaning they consider it among “the least attractive stocks” in the industry.

Maquina da Noticia, an external relations company that represents the brokerage, said in an e-mailed statement that the analysts wouldn’t comment on Smiles beyond the contents of the report, which still reflects their current view of the company.

Gol’s press office said in a e-mailed response to questions that it wouldn’t comment on its stock performance. Chief Executive Officer Paulo Sergio Kakinoff said in an Aug. 12 statement when the company released second-quarter earnings that Gol has “a robust cash position, an adequate debt profile, an efficient cost structure and focus on its flights’ profitability.”

Smiles was the frequent flier program run by the carrier known as Varig, once Brazil’s largest, which filed for bankruptcy protection before being sold to Gol in 2007. With Gol now struggling to cut costs and return to profit, the Smiles IPO diminished the risk of the airline’s troubles spilling over to its subsidiary, Banco do Brasil’s Daltozo said.

“After the IPO, people can see more clearly that, no matter what happens with Gol, Smiles can stand on its own legs,” he said.

To contact the reporter on this story: Ney Hayashi in Sao Paulo at ncruz4@bloomberg.net

To contact the editor responsible for this story: David Papadopoulos at papadopoulos@bloomberg.net

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